Monday, December 1, 2008

Bernanke is saying that the Fed is not out of options, even though the Federal Funds rate is only 1%. As Bloomberg writes:

The Federal Reserve has lowered interest rates just about as far as they can go, but the U.S. central bank still has plenty of available firepower it could deploy to restore financial markets to normal, Fed Chairman Ben Bernanke said Monday.

The Fed could buy Treasury notes and bonds or agency bonds in a bid to drive yields lower and "spur aggregate demand," Bernanke said. Many analysts refer to such a policy as "quantitative easing," because the Fed would target a specific amount of money to flood into the economy. ***

"The second arrow in the Federal Reserve's quiver - the provision of liquidity - remains effective," he said. "The Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand."

The politicians don't want to let the downturn correct itself and let malinvestments work their way through the system. So the government will use all of the weapons in its arsenal to try to prevent a further downturn.

The Fed (or Treasury) could even go as far as directly intervening in the stock market via direct purchases of equities as a way to boost falling equity prices. Some of such policy actions seem extreme but they were in the playbook that Governor Bernanke described in his 2002 speech on how to avoid deflation.

Of course, the PPT is already directly buying stocks as a way to boost falling equity prices. But it is possible that the government will go public with such purchases so as to dramatically increase the volume, so that it can more dramatically game the stock market.

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